• Share markets rebounded over the last week as share investors became a bit more relaxed about the prospect of higher inflation and interest rates and the unwinding of short volatility trades ran its course. However, the rebound has been concentrated in the US share market which rose 4.3% over the last week (and is up 7% from its recent low), with Europe up 3.2% over the week, Japan up 1.6% and Australia up 1.1% - all lagging. Chinese shares rose 3.3% in a holiday shortened week. The Australian share market never fell as much on the way down but a resumption of the falling US dollar likely played a role in the relative outperformance of US shares over the last week as it boosts US profits and constrains profits in Europe, Japan, Australia, etc. Bond yields were up a bit over the week in the US and Australia but fell slightly in Europe and Japan. Commodity prices and the Australian dollar rose helped by renewed US dollar weakness and as investor confidence returned, although the gains were curtailed a bit as the $US recovered some of its losses late in the week.
  • While share markets have settled down to varying degrees, the strength of the US economy with fiscal policy providing an additional boost is likely to ensure that inflation will be a growing issue this year globally and we remain of view that market expectations regarding Fed rate hikes are too complacent. The next chart shows that US money market rate hike expectations are still well below what the Fed has signalled and so a further shifting up in market interest rate expectations is likely and this will drive a further rise in bond yields.

 

 

Australian economic events and implications

  • As has long been the case in recent years, Australian data was mixed. On the one hand business condition and confidence rose in January according to the NAB survey and employment rose solidly. But against this consumer confidence slipped a bit in February and the quality of the jobs report was poor with a sharp fall in full time jobs and slowing hours worked.  On the jobs front, job vacancies and job ads point to continued strength but employment has overshot the strength in jobs leading indicators and so may undershoot for a while and more significantly after a good rebound in full time jobs last year we may be reverting back to lower quality part time jobs as the main driver of employment.
  • For those trying to understand why the RBA is lagging behind the Fed in raising rates (apart from the fact that the Fed cut far more than the RBA did in the first place), the chart below is a good place to start. Basically, labour market underutilisation (or unemployment plus underemployment) is far higher in Australia than in the US. This means it will take longer for wages growth to pick up in Australia and for the RBA to hike rates. 

 

  • On the interest rate front, RBA Governor Lowe’s Parliamentary testimony basically repeated the Bank’s message of the last few weeks which is that the next move on rates will most likely be up, the economy is moving in the right direction, we have seen more positive economic news in recent months, but uncertainty remains around the consumer and progress in reducing unemployment and having inflation return to target is likely to be gradual. As such the RBA “does not see a strong case for a near-term adjustment of monetary policy”. We agree and don’t see a rate hike until late this year at the earliest.
  • It’s still early days in the December half profit reporting season with only a third of companies having reported, but so far it remains reasonably good. 46% of results have exceeded expectations against a norm of 44%, 74% have seen profits rise from a year ago and 72% have increased dividends from a year ago. However, only about 49% have seen their share price outperform on results day and there is still a way to go yet with results often tailing off a bit as more report.

What to watch over the next week

  • In the US, the minutes from the last Fed meeting (Wednesday) are likely to attract greater than usual attention but are likely to do little more than affirm that the Fed is on track for another hike next month. Meanwhile, expect the Markit business conditions PMIs for February to have remained solid and existing home sales to gain (also both due on Wednesday).
  • Eurozone business conditions PMIs for February will also be released on Wednesday and are likely to have remained strong.
  • In Japan, the manufacturing PMI for February (Wednesday) is likely to have remained strong but core inflation for January (Friday) is likely to remain around 0.3% year on year which is well below the 2% target and will prevent any imminent easing in easy money from the Bank of Japan.
  • In Australia, the minutes from the RBA’s last board meeting (Tuesday) are likely to confirm that it’s a bit more upbeat but that with the move back to the mid-point of the inflation target likely to be gradual it’s in no hurry to raise interest rates. December quarter wage data to be released on Wednesday are likely to show wages growth of just 0.5% quarter on quarter of 2% year on year, consistent with the RBA remaining on hold for some time. Meanwhile, December quarter construction activity data (also Wednesday) will likely fall back after a strong gain in the September quarter.
  • The Australian December half 2017 earnings reporting season will really ramp up in the week ahead with around 80 major companies reporting including Seek (Monday), Oil Search and BHP (Tuesday), Worley Parsons, Wesfarmers, Lend Lease and Fairfax (Wednesday), Qantas and Crown (Thursday) and Woolworths (Friday). This reporting season is expected to see a fall back to single digit earnings growth (after the resource driven surge seen in 2016-17) with overall earnings growth around 7% (compared to around 16% in the last financial year), with resources profit growth slowing to around 14% (from 130% in 2016-17) but still supported by solid commodity prices and production growth, bank earnings growing around 3% and industrials up 5% with strong results for insurers, utilities, healthcare, building materials and consumer discretionary. The main themes will be continued strength in companies exposed to housing construction and the infrastructure spending boom, the impact of the US tax cut on companies exposed to the US and the potential for some special dividends and capital returns.